Analysis: FL RL ANF COST AMZN WMT TGT TJX ROST HD KSS BJ ABNB UAL

Bloated retailer inventories have been a concern. They rose considerably exiting the April quarter, hitting peak levels that even surpassed expected inventory builds for the all-important holiday shopping season. Now, Foot Locker (FL)  has reported its quarterly results, and its inventories were also at rather elevated levels. Net inventories at Ralph Lauren (RL) rose 29% to one of the highest level in several years, while inventory levels at Abercrombie & Fitch (ANF) soared 45% year-over-year exiting its April quarter.

While some companies are attempting to paint the rise in inventories as a smart move, given supply chain woes, the overriding concern we have -- as we noted last week -- is what's likely to come as consumer borrowing costs move higher and disposable income is pressured by inflation. That combination as well as consumer concerns for a slowing economy could throttle back spending plans, leading retailers to contend with higher than expected inventory levels. As we've seen in the past, retailer margins on clearance items tend to be quite a bit lower than full price items, and if they have to clear out more inventory than previously expected it means a degrading margin profile could to weigh on bottom line expectations in the next few quarters.

As members know, our exposure to retail is rather limited with Costco (COST) , Amazon (AMZN) , and Walmart (WMT) . With Costco and Amazon, we have very different than the norm business models. As we've shared quite often, Costco's membership business model makes it a standout while Amazon has its Amazon Web Services (AWS) business. While Walmart has a membership business its influence on the company's overall bottom line is far smaller than that for Costco given that it accounts for around 15%-20% of total operating income compared to 55%-60% at Costco.

Walmart is the largest grocer in the U.S. and we like that that tends to spur repeat visits and should continue to do so as consumers look to overcome higher food prices. But the company's overall inventory levels were still at historic levels exiting the April quarter. At $61.2 billion, Walmart's inventory exiting April was larger than all the inventory at Target (TGT) , Foot Locker, TJX Companies (TJX) , Ross Stores (ROST) , Home Depot (HD) , Kohl's (KSS) , and BJ's Wholesale (BJ) combined. Another way of looking at it, Walmart's inventory exiting April was 75% higher than that at Amazon.

The conjures up renewed concerns over margin pressure for Walmart in the back half of 2022, especially given its operating model while impressive in size and scope is still essentially a traditional one. As we shared after Walmart reported its April quarter:

"Walmart sees its operating income and EPS flat to up in the current quarter, which more than likely means the worst of the margin pressure occurred in the April quarter. Parsing its guidance for the full year, management sees operating income flat year over year, which translates to a stronger second half of the year as it overcomes the year over year declines in the first half.

The same goes for its full-year EPS, which is expected to be down 1% vs. last year which implies $6.40 vs. the $6.76 pre-April quarter consensus. Given the April quarter's EPS of $1.30 and the company's EPS guidance for the current quarter of "flat to up slightly" it means Walmart now expects its EPS in the second half of the year to be something like $3.70-$3.75, up more 35% compared to the first half of the year.

That would be the strongest levels of EPS growth in some time -- tracing Walmart's second half EPS growth vs. the first half over the last several years, it's ranged from effectively 0% to a high of 19.5% in 2015. We are somewhat skeptical the company can deliver that level of EPS growth in the second half, especially if fuel costs remain at elevated levels.

With the prospects for a more challenges for traditional retail operating models, we're downgrading Walmart shares to a "Three" rating, something we hinted at on yesterday's Daily Rundown. In keeping with what we said then, our plan will be to use near-term strength to work our way out of WMT shares, balancing the returned capital between the portfolio's cash position and companies with far more defensive business models.

We would also share with members that given the more the rough road we're on, we will continue to revisit the rest of the existing portfolio. A particular focus is those positions that continue to be under pressure even though the data is favorable. Case in point is Airbnb (ABNB) , which continues to hit new lows of late despite United (UAL)  recently boosting its revenue outlook and travel numbers that remain strong compared to 2021 levels. By our calculations, the Transportation Security Administration checkpoint travel numbers quarter-to-date are up almost 45% year-over-year. But we have to recognize that unlike several months ago or this time last year, we are now in a bear market and that means stocks of all types get "swiped at" no matter what the fundamentals may point to. As we said recently it means bad news is bad news, and good news isn't enough. As we look to limit further losses for the portfolio, we'll continue to chew on the above for Airbnb as well as one to two other stocks that in a similar boat.

AAP is long AMZN, WMT, COST, ABNB